LEGISLATIVE UPDATE
Eye on Washington
U.S. Supreme Court Rules That Severance
Payments Are Wages Subject to FICA Taxes
On March 25, 2014, the U.S. Supreme Court (the Court) in United States v. Quality Stores, Inc. unanimously overturned a lower-court
decision and held that severance payments made to involuntarily terminated employees are “wages” subject to Federal Insurance
Contributions Act (FICA) taxes. The Court largely followed the broad definition of wages (and employment) for FICA purposes under
Internal Revenue Code (IRC) Sections 3121(a) and (b) and prior Supreme Court precedents to support its decision.
Background:
The issue of whether certain types of severance pay may be
excluded from FICA withholding first became a noteworthy
topic back in 2002, in CSX Corp. v. United States, when the U.S.
Court of Federal Claims determined that certain involuntary
layoff payments could be exempt from FICA, if those payments
qualified as supplemental unemployment compensation
benefits (SUB payments) under IRC Section 3402(o)(2). This
initial decision prompted many employers to file refund claims
for FICA taxes withheld on these types of severance payments,
which the Internal Revenue Service (IRS) put on hold while the
appeal was pending. In 2008, the U.S. Court of Appeals for the
Federal Circuit reversed the lower-court decision in CSX Corp.
As a result, the IRS disallowed the refund claims for FICA taxes
on those benefits that had been held.
On February 23, 2010, this issue was raised again in United
States v. Quality Stores, Inc., when the U.S. District Court
for the Western District of Michigan affirmed a bankruptcy
court’s decision that severance payments made to employees,
pursuant to an involuntary reduction in force, were not “wages”
for FICA tax purposes. The IRS appealed the ruling to the U.S.
Court of Appeals for the Sixth Circuit. On appeal, the U.S.
Court of Appeals for the Sixth Circuit held that the severance
payments made by Quality Stores, Inc. were properly classified
as SUB payments and that such payments were not wages for
purposes of FICA tax withholding.
Since there was a split in the circuits regarding whether
severance benefits were subject to FICA tax, the Quality Stores
case was appealed to the U.S. Supreme Court. The Court
held that severance payments, including SUB payments, do
fall within the definition of “wages” for FICA tax purposes. In
its decision, the Court reasoned that severance payments,
including SUB payments, are “remuneration for employment”
due to the fact that:
• they are made only to employees who have been terminated;
• typically are varied based on job seniority and position; and
• are often used to attract employees
The Court noted that the severance payments made by Quality
Stores, Inc. were:
• made to employees terminated against their will;
• were varied based on job seniority; and
• were not linked to the receipt of state unemployment benefits
As a result, such payments constituted “wages” for FICA tax
purposes.
The U.S. Supreme Court ruling in Quality Stores upholds the
IRS’s long-standing position that severance pay – regardless of
whether it is paid pursuant to a reduction in force – constitutes
wages subject to FICA withholding. As a result, employers that
filed protective refund claims following the Sixth Circuit’s earlier
decision will not be entitled to a refund of FICA taxes.
ADP Compliance Resources
ADP maintains a staff of dedicated professionals who carefully monitor federal and state legislative and regulatory measures
affecting employment-related human resource, payroll, tax and benefits administration, and help ensure that ADP systems are
updated as relevant laws evolve. For the latest on how federal and state tax law changes may impact your business, visit the
ADP Eye on Washington Web page located at www.adp.com/regulatorynews.
ADP is committed to assisting businesses with increased compliance requirements resulting from rapidly evolving legislation. Our goal is to help
minimize your administrative burden across the entire spectrum of employment-related payroll, tax, HR and benefits, so that you can focus on running
your business. This information is provided as a courtesy to assist in your understanding of the impact of certain regulatory requirements and should
not be construed as tax or legal advice. Such information is by nature subject to revision and may not be the most current information available. ADP
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Last updated: May 1, 2014